IRS cautions against “dumping” employees on health insurance Exchange

IRS has posted Questions and Answers (Q&As) on its website that address the consequences of an employer reimbursing its employees for the premiums they pay for health insurance—i.e., health insurance through a qualified health plan in the health insurance exchange or outside the exchange—rather than establishing a health insurance plan for its own employees. Such a “dumping” strategy has been proposed by some as an inexpensive way to shift the expense of providing employee health care away from the employer, requiring only that the employer provide its employees with what was assumed would be tax free cash contribution to their employees towards paying their health insurance premiums. IRS’s guidance concluded that, while under such arrangements an employee may have an after-tax amount applied toward health coverage or take that amount in cash compensation, these arrangements are considered to be group health plans subject to the market reforms provisions under the Affordable Care Act (ACA) and the penalty for failure to meet those provisions.

Background on employer mandate. Under provisions in the ACA, an applicable large employer is liable for an annual assessable payment if any full-time employee is certified to the employer as having bought health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee, and either the employer: (1) fails to offer to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage (MEC) under an eligible employer-sponsored plan (Code Sec. 4980H(a)); or (2) offers its full-time employees (and their dependents) the opportunity to enroll in MEC under an eligible employer-sponsored plan that, for a full-time employee who has been certified as having enrolled in qualified health plan for which an applicable premium tax credit or cost-sharing reduction, either is unaffordable or does not provide minimum value (as these terms are defined in Code Sec. 36B(c)(2)(C)). (Code Sec. 4980H(b)). Together, Code Sec. 4980H(a) and Code Sec. 4980H(b) are called “employer shared responsibility” provisions or the “employer mandate.”

As enacted, the employer mandate was to apply for months beginning after Dec. 31, 2013, but IRS delayed implementing the employer penalty for all employers until 2015. Subsequently, IRS delayed the applicability of the employer mandate to mid-sized employers (i.e., those with between 50 and 99 full-time employees) until 2016, provided that the employer meets certain requirements. They also provided a “phase-in” rule for large employers (i.e., with 100 or more full-time employees) under which an employer won’t owe a penalty for failing to offer health coverage so long as it offers coverage to at least 70% of its full-time employees in 2015, and 95% in 2016 (see Weekly Alert ¶ 4 02/13/2014).

Background on employer payment plans. In September of 2013, IRS issued guidance on the application of the so-called “market reform” provisions of the ACA to health reimbursement arrangements (HRAs), health flexible spending arrangements (health FSAs), and certain other employer healthcare arrangements. Market reform provisions include the “annual dollar limit prohibition,” which provides that a group health plan (or a health insurance issuer offering group health insurance coverage) may not establish any annual limit on the dollar amount of benefits for any individual (Public Health Service Act (PHSA) §2711); and the “preventive services requirements,” which require non-grandfathered group health plans (or health insurance issuers offering group health insurance plans) to provide certain preventive services without imposing any cost-sharing requirements for these services (PHSA §2713). The Code Sec. 4980D excise tax is imposed for violations of these market reform PHSA provisions. (Notice 2013-54, 2013-40 IRB 287, see Weekly Alert ¶ 3 09/19/2013)

The guidance in Notice 2013-54 covered “employer payment plans”—group health plans under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy, or arrangements under which the employer uses its funds to directly pay the premium for an individual health insurance policy covering the employee. Notice 2013-54 looked to the treatment of employer payment plans under Rev Rul 61-146, 1961-2 CB 25, which holds that if an employer reimburses an employee’s substantiated premiums for non-employer sponsored hospital and medical insurance, the payments are excluded from the employee’s gross income under Code Sec. 106. This exclusion also applies if the employer pays the premiums directly to the insurance company.

However, Notice 2013-54 provides that an “employer payment plan,” does not include an employer-sponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan.

New guidance. On its website, IRS explained the consequences to an employer if it does not establish a health insurance plan for its own employees, but instead reimburses its employees for the premiums they pay for health insurance either through a qualified health plan in the exchange (also know as the marketplace) or outside the exchange.

An employer payment plan, as described in Notice 2013-54, generally does not include an arrangement under which an employee may have an after-tax amount applied toward health coverage or take that amount in cash compensation.

Further, as explained in Notice 2013-54, these employer payment plans are considered to be group health plans subject to the market reform requirements, including the prohibition on annual limits for essential health benefits and the requirement to provide certain preventive care without cost sharing. Such arrangements cannot be integrated with individual policies to satisfy the market reform requirements. As a result, these arrangements fail to satisfy the market reform requirements, and the employer may be subject to a $100/day excise tax (that is, $36,500 per year per employee) under Code Sec. 4980D.